The four types of adult Isa — cash, stocks and shares, Lifetime and Innovative Finance — can each come into play at different points in your life. Whether you are buying your first home, paying off your mortgage or preparing for retirement, Isas can help you to achieve your money goals.
Which do you need now? We asked some money experts to help to guide our readers to the best Isa for their present situation.
The first-time buyer
Charlotte Earl, 21, is living with her parents in South Croydon in south London while she saves for a house deposit. She graduated with a lot of student debt, but is not paying off much because she does not yet earn enough as a civil servant to trigger higher payments.
She has paid £2,000 into a Lifetime Isa and is aiming to save between £400 and £800 a month with a view to buying a property within the next two years.
She wants to save £20,000, which she thinks would give her a 10 per cent deposit on a one-bedroom flat in the Croydon area, but she may also need a loan from her parents to cover the extra costs incurred in buying a property. “I’m hoping to go into hyper-savings mode from this point on, and hopefully my salary will increase so I can save more,” Earl said.
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While she has considered opening a stocks and shares Isa, she worries about market volatility and the possibility of losing money. Her goal is to save as much as she can so she can buy before house prices start going up again.
● Five ways to improve the Lifetime Isa
More than half a million people paid into Lifetime Isas in the 2020-21 tax year, the most since they were launched in 2017. These accounts is designed to help first-time buyers to save towards their first home, with a 25 per cent bonus from the government offered on everything you save up to £4,000 each tax year.
That annual savings limit means that Earl cannot save £800 a month into her Lifetime Isa over a year, said Cecily Chapman, a financial adviser at Carrington Wealth Management. Paying in £333 a month would take her to the limit. “Then she could add the rest to a normal Isa as she would have £16,000 left of her Isa allowance,” Chapman said. The allowance is £20,000 a year.
“There are decent rates on cash savings now so she doesn’t need to invest this money. In fact, I would say don’t invest it if you want to buy in the next two years because it’s too short-term.”
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Earl is unlikely to pay tax on her savings interest because the personal savings allowance lets her earn £1,000 a year without paying tax. This means that the tax-free element of an Isa is less important, so Earl could look at different types of cash savings accounts to find the best deal.
Cash Isas are the most popular type of Isa by far, but they have not paid great interest rates for some time because the Bank of England base rate has been so low. The average cash Isa paid 0.8 per cent in 2022. With the base rate now at 4 per cent , however, rates are improving. The top one-year cash Isa on March 7 was the Virgin Money 1 Year Fixed Rate Cash Isa paying 4.25 per cent. That’s only slightly less than the best one-year savings bond paying 4.31 per cent from SmartSave, according to the data firm Moneyfacts, but returns are tax-free for life.
“One downside of a Lifetime Isa is that you’re limited to a property costing £450,000 or less,” Chapman said. “Earl is aiming for a £200,000 flat, which is well within the limit, but if her plans change or she met someone and wanted to buy with them and the budget increased, they run the risk of not being able to use it.”
If that happened she would have to pay a 25 per cent penalty to withdraw her money. This is charged on the total pot, so she would lose a net 6.25 per cent of her own savings to the government.
The mortgage-free saver
Rachel Howlett, 46, lives in Bedfordshire in a flat she bought in 2016. She had worked as a theatre lighting operative until Covid hit her industry hard. When she was made redundant in 2020 she used the payout and some savings to clear her mortgage.
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Rachel is now a self-employed gardener and home help, and cares for an elderly relative. While she is unable to save much because her earnings have dropped, she is putting £50 a month into a private pension. She also has more than £20,000 in savings, which she recently moved from Premium Bonds to a cash Isa as interest rates were rising.
Rachel is unsure whether a cash Isa, stocks and shares Isa or Premium Bonds would be the best way to grow her money. “My priority is to maximise the interest I can get on the savings I do have because I’m not going to be able to put anywhere near as much aside now that the cost of living is going up. What I do save, I want to make the most of.”
The money experts agree that Rachel should first designate some of her cash savings as an emergency fund covering three to six months’ expenses. Premium Bonds are instant access, so she could use these as a home for her emergency fund, said Makala Green, an adviser at Schroders Personal Wealth.
Premium Bonds do not pay a guaranteed interest rate, but they have an effective prize rate based on the average you can expect to win, which is currently 3.15 per cent. If you don’t win a big prize, the rate you get works out at less than 1 per cent a year.
Mike Stimpson, a partner at the wealth manager Saltus, said Rachel should put the rest of her money in a stocks and share Isa (also called an investment Isa) in the hope of higher returns. You can hold individual funds, shares, cash or a combination of these.
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Any gains in an Isa are tax-free, so using one could help Rachel to control her overall tax liability and supplement the taxable income taken from her pension. “It could be a great addition to her pension income in retirement,” Stimpson said. Adult savers invested almost £34 billion in stocks and shares Isas in 2021-22.
“Saving £50 a month into her pension is absolutely the right thing to have done because of the valuable tax uplift,” Stimpson said. “However, Rachel will not be able to access that cash until she is 57 as the minimum pension age increases in April 2028, and this is something to consider when thinking about her other savings.”
Should Rachel also consider an Innovative Finance Isa for growth potential? Financial advisers tend to dislike this Isa because it involves investing in peer-to-peer loans that are too risky for most novice investors.
Several P2P lenders have gone bust in the past few years. “I wouldn’t recommend them because there’s no need to take that risk,” said Steven Rowe, a director at Lucent Financial Planning. “You can invest in great companies across the world that have worked for decades without the same risk of losing all your money.”
Innovative Finance Isas are the least popular of the four types: 16,000 of them received subscriptions in 2020-21, half the number in the previous tax year.
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The retired person
Jane Shotliff, 63, recently downsized from a three-bedroom grade II listed cottage in Kent to a two-bedroom terrace in Fleetwood. She had worked for a company that sold retirement properties, but when her role changed during the pandemic she decided to stop working and move to a cheaper part of the country.
Shotliff generated £250,000 from the sale of her old house and has no mortgage on her new home. Two old workplace pensions give her an income of about £600 a month, and she also does some freelance PR and part-time bar work. She has a pension from her divorce settlement that she has not yet touched and has dabbled in cryptocurrencies, but made a loss.
Some of her money is invested with a financial adviser, including £20,000 in a stocks and shares Isa, and some is in her current account. Shotliff has two grown-up daughters and is not sure if grandchildren are on the cards, but if any do come along she would like to know how best to save for them.
She is considering buying a rental property to give her extra income, but is unsure and, overall, feels she has no clear strategy for the future. She wants to make her money last the rest of her retirement. “I do like my holidays — I had seven last year — so I am getting through my money at a rate of knots,” she said.
“To me, Shotliff’s story screams out ‘financial advice’,” Green said. He said she should sit down with her financial adviser and review her portfolio to make future plans. “If she does want to take seven holidays a year, she can work out the cost and decide the best source of growth or income to achieve that,” Green said. “Buying a second property can be a great source of income, but you have to factor in the additional costs such as stamp duty, income tax and ongoing management.”
Shotliff should be mindful of inflation and not hold more than she needs to in cash. Many people don’t see cash as risky, but with inflation running at nearly 10 per cent and cash savings earning about 3 per cent, savers are losing money in real terms. Putting more into an investment Isa could reduce the impact of inflation and give her money more chance to grow, Green said.
If she becomes a grandmother, she could put up to £9,000 every tax year into a Junior Isa for each grandchild and the money would grow tax-free. When the child reaches 18, the money will be theirs to withdraw. The cash version of the Junior Isa is the most popular choice for parents and grandparents, but this is a missed opportunity because, with up to 18 years for the money to grow and recoup any losses, Junior Isas are a great vehicle for long-term investing.
The average saved into a Junior Isa over the past ten years is £64 a month. In a cash Junior Isa, this would be worth £7,857 after a decade, or £13,470 if it was invested in global stock markets, according to Janus Henderson Investors.
“Junior Isas are a great way to build a solid financial foundation for your grandchildren, and also to move money outside your estate for inheritance tax,” Green said.
